As extensively reported, there's been an interesting experiment going on in Europe and Japan in recent years, as central banks have pushed short-term nominal interest rates into negative territory in an attempt to stimulate economic growth. The table below shows a matrix of current nominal yields for each country, plus their current inflation rate:

It appears the tipping point at which it becomes more worthwhile for investors to move to physical cash must be about -0.75%. At short-term rates any lower than this, it likely makes more financial sense for investors to set up private vault systems and start filling them with physical cash!

U.S. investors are very fortunate to have escaped the affliction of negative interest rates — at least for this economic cycle.

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

I suppose this makes sense when one can get an SEC yield of 1.3% on Vanguard's Limited-Term Tax-Exempt fund today, but only negative interest rates on your shorter-term government bonds at home.

How very strange. I must be missing something, because it still doesn't make sense to me. Why wouldn't they invest in Vanguard Intermediate-Term Treasury Fund Admiral Shares (VFIUX) instead? They get a similar duration, but with an SEC yield of 1.97% and at a lower risk of default. Why own the munis at a lower yield, if not for the tax advantage?

How very strange. I must be missing something, because it still doesn't make sense to me. Why wouldn't they invest in Vanguard Intermediate-Term Treasury Fund Admiral Shares (VFIUX) instead?

I'm sure they do. I was just comparing yields on the shorter end of the yield curve, where rates are markedly negative in Europe and Japan. For intermediate-term bonds, except for Switzerland, all other countries' 10-year sovereigns are at least in positive territory — so there's less motivation to take the currency risk with U.S. bonds.

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

As extensively reported, there's been an interesting experiment going on in Europe and Japan in recent years, as central banks have pushed short-term nominal interest rates into negative territory in an attempt to stimulate economic growth. The table below shows a matrix of current nominal yields for each country, plus their current inflation rate:

It appears the tipping point at which it becomes more worthwhile for investors to move to physical cash must be about -0.75%. At short-term rates any lower than this, it likely makes more financial sense for investors to set up private vault systems and start filling them with physical cash!

U.S. investors are very fortunate to have escaped the affliction of negative interest rates — at least for this economic cycle.

Thoughts?

It is forward inflation rates that count not current inflation.

But what you are seeing here is impact of Central Banks gobbling up government bonds BoJ and ECB are still net buyers.

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

How very strange. I must be missing something, because it still doesn't make sense to me. Why wouldn't they invest in Vanguard Intermediate-Term Treasury Fund Admiral Shares (VFIUX) instead?

I'm sure they do. I was just comparing yields on the shorter end of the yield curve, where rates are markedly negative in Europe and Japan. For intermediate-term bonds, except for Switzerland, all other countries' 10-year sovereigns are at least in positive territory — so there's less motivation to take the currency risk with U.S. bonds.

I'm curious if retail clients and the average person on the street ever saw negative interest rates on their deposits? Or is this the negative rate primarily between the central bank and other lending institutions?

I'm curious if retail clients and the average person on the street ever saw negative interest rates on their deposits? Or is this the negative rate primarily between the central bank and other lending institutions?

Back when I used to prowl expat mailing lists, I heard regular complaints from expats in Europe about negative interest rates. Ironically, high-dollar accounts tended to be hit first. You'd think a bank would want to encourage people to leave their $100k at rest for the bank to leverage, rather than punishing them until they move it somewhere else, but whatever...

The real yield on TIPS will be even more negative than the nominal yield on a Treasury of same maturity, assuming a positive inflation expectation. Although we haven't seen negative nominal yields in the US, we have seen negative TIPS yields. The 5-year TIPS yield hit -1.67% on 9/14/2012, when the 5-year Treasury yield was 0.72%.

Wouldn't investors simply move toward investments with higher yields?

Some do--it's called "chasing yield". Why do you think we've seen all the talk about using high-dividend paying stocks as a substitute for bonds and other fixed income? To earn higher yields, you must take more risk. Sticking with fixed income, you get that either by extending maturity and taking more term risk (assuming positively-sloped yield curve), or by taking more credit risk. You see the former even in SimpleGift's chart, showing red turning to green as you extend maturity.

But what you are seeing here is impact of Central Banks gobbling up government bonds BoJ and ECB are still net buyers.

Yes, it appears they will continue to be net buyers for a few years to come. From a Financial Times article today:

Financial Times wrote:Bond buying by the Bank of Japan and European Central Bank is set to exceed new issuance over the next five years, pushing private investors out of those markets. That leaves only the US as a substantial source of highly rated sovereign debt, the IMF found.

Investors in highly rated sovereign debt will be dependent on the US Treasuries market for a supply of new issuance over the next five years, as central banks’ bond-buying continues to crowd out private demand in Japan and Europe, according to data recently released by the IMF.

The real yield on TIPS will be even more negative than the nominal yield on a Treasury of same maturity, assuming a positive inflation expectation. Although we haven't seen negative nominal yields in the US, we have seen negative TIPS yields. The 5-year TIPS yield hit -1.67% on 9/14/2012, when the 5-year Treasury yield was 0.72%.

Wouldn't investors simply move toward investments with higher yields?

Some do--it's called "chasing yield". Why do you think we've seen all the talk about using high-dividend paying stocks as a substitute for bonds and other fixed income? To earn higher yields, you must take more risk. Sticking with fixed income, you get that either by extending maturity and taking more term risk (assuming positively-sloped yield curve), or by taking more credit risk. You see the former even in SimpleGift's chart, showing red turning to green as you extend maturity.

Kevin

Thanks for taking the time to put in the chart for my simple brain to understand.
If TIPS are supposed to adjust to inflation, I still don't quite get how it goes negative. . .or does the means it follows deflation as well?

Thanks for taking the time to put in the chart for my simple brain to understand.

You're welcome!

If TIPS are supposed to adjust to inflation, I still don't quite get how it goes negative. . .or does the means it follows deflation as well?

The TIPS yield is a real yield, which means the nominal yield that you earn includes the inflation adjustment. So if the TIPS yield is -1% and the inflation for the adjustment period is 2%, your nominal yield would be +1%. So a negative TIPS yield does not mean that there's deflation, it just means that the real yield (roughly the nominal yield minus the inflation expectation) is negative, as in the example I just gave.

Thanks for taking the time to put in the chart for my simple brain to understand.

You're welcome!

If TIPS are supposed to adjust to inflation, I still don't quite get how it goes negative. . .or does the means it follows deflation as well?

The TIPS yield is a real yield, which means the nominal yield that you earn includes the inflation adjustment. So if the TIPS yield is -1% and the inflation for the adjustment period is 2%, your nominal yield would be +1%. So a negative TIPS yield does not mean that there's deflation, it just means that the real yield (roughly the nominal yield minus the inflation expectation) is negative, as in the example I just gave.

It hasn't ended in Japan, yet, and they've been experimenting with very low interest rates for over 2 decades.

I think the ECB is going to be stuck, it's not going to be able to unwind QE for quite a long time to come. The Eurozone will neither spring to inflationary life, nor crash into depression, but just keep ticking over- -economic growth at the moment is actually quite good but the unemployment picture in the Eurozone is still pretty ugly. Inflation is quiescent.

Last edited by Valuethinker on Thu Nov 16, 2017 10:45 am, edited 1 time in total.

I'm curious if retail clients and the average person on the street ever saw negative interest rates on their deposits? Or is this the negative rate primarily between the central bank and other lending institutions?

Oh they are quite real. You pay the bank for looking after your money.

At least in Sweden, people were/ are taking money out of their accounts and keeping it in cash (stored in the microwave in one case at least).

Usually small retail accounts are OK. I believe.

It does depend whether you have a free banking model. In the UK, account payers pay very few service charges, so the fall in interest rates is hurting the banks (and service charges, where levied, have gone up).

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

I suppose this makes sense when one can get an SEC yield of 1.3% on Vanguard's Limited-Term Tax-Exempt fund today, but only negative interest rates on your shorter-term government bonds at home.

Amazed you did not think of exchange rate risk?

The currency forward rate will wipe out the profit. All studies suggest Covered Interest Parity holds. Maybe a market maker can make money from this trade but any investor will take on currency risk.

Why can't foreign investors hedge this risk just the same as US investors do in e.g. a hedged international bond fund?

The Build America Bond program was introduced in 2009 and thus there was a large increase in "taxable" municipal bonds in the market. Not all "municipal" bonds are tax-exempt municipal bonds. The taxable BAB program was designed to attract non-profit endowments and foreign investors who did not benefit from the normal tax-exempt municipal bonds. I don't know the underlying data of this chart, but the spike may be due to foreign investors buying increasing supplies of taxable municipal bonds around 2009 and beyond. The chart does not specify that foreigners were buying tax-exempt municipal bonds. Just a thought.

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

I suppose this makes sense when one can get an SEC yield of 1.3% on Vanguard's Limited-Term Tax-Exempt fund today, but only negative interest rates on your shorter-term government bonds at home.

Amazed you did not think of exchange rate risk?

The currency forward rate will wipe out the profit. All studies suggest Covered Interest Parity holds. Maybe a market maker can make money from this trade but any investor will take on currency risk.

Why can't foreign investors hedge this risk just the same as US investors do in e.g. a hedged international bond fund?

The Build America Bond program was introduced in 2009 and thus there was a large increase in "taxable" municipal bonds in the market. Not all "municipal" bonds are tax-exempt municipal bonds. The taxable BAB program was designed to attract non-profit endowments and foreign investors who did not benefit from the normal tax-exempt municipal bonds. I don't know the underlying data of this chart, but the spike may be due to foreign investors buying increasing supplies of taxable municipal bonds around 2009 and beyond. The chart does not specify that foreigners were buying tax-exempt municipal bonds. Just a thought.

Ahh, yes. That would account for it.

With the ECB and BOJ gobbling up debt, the remaining high quality debt pool is smaller, and that will drive demand from non US investors.

I've seen this with European Fin Instns & funds buying Covered Bonds (mortgage backed securities but with final recourse of the bonds onto the issuer, ie the bank originating the mortgages) issued by Canadian banks. So EFI have contributed to Cdn housing bubble (if it is one, and I think it is).

Does the cash in the brokerage account also incur negative interest rate?

There has to be better methods of storing money than putting the bundles in microwave.

I don't think most Europeans have stockbroking accounts -- investing is done direct through banks or insurance companies.

However a brokerage account does not qualify for the EUR 100k deposit insurance. it is not risk-free. (Sweden uses the SKR but the deposit insurance level is EU wide not just Eurozone; note Switzerland is not covered AFAIK).

It is not like-for-like in other words between the 2 types of accounts.

I don't know what an EUR brokerage account pays in interest, mine pays 0% but it is in GBP with a UK bank.

Does the cash in the brokerage account also incur negative interest rate?

There has to be better methods of storing money than putting the bundles in microwave.

I don't think most Europeans have stockbroking accounts -- investing is done direct through banks or insurance companies.

Yes, many banks offer a brokerage account associated with a normal bank account, or along with insurance companies offer convoluted products with (hidden) fee structures which would not get bogleheads approval. But there's also many "pure" brokers, which are getting more popular because they usually have lower fees compared to banks.

However a brokerage account does not qualify for the EUR 100k deposit insurance. it is not risk-free. (Sweden uses the SKR but the deposit insurance level is EU wide not just Eurozone; note Switzerland is not covered AFAIK).

It is not like-for-like in other words between the 2 types of accounts.

I don't know what an EUR brokerage account pays in interest, mine pays 0% but it is in GBP with a UK bank.

Nowadays you have 0% interest on brokerage accounts in EUR. But there's a popular broker in Germany (by the name of flatex) which charges 0.4% negative interest on positive account balances. But as you say, the broker's clients more like average do-it-yourself investors, not "average persons". Average people still get minuscule positive interest rates in bank accounts. The financial difference between 0% and 0,01% is neglectable, but people sure see it differently from an emotional point of view (it's not zero ).

With the prospect that the Bank of Japan and the European Central Bank will continue to purchase bonds in the years ahead — and on a scale that exceeds new issuance — it's likely that the amount of global debt with sub-zero yields will continue to grow.

Other than those, bond yields are set by continuous, ongoing auctions. Nobody buys a bond with a yield to maturity, YTM, lower than they will accept, even if it's negative.

Individual investors like us, including the very wealthy, have options institutions often do not. Imagine a company like Facebook trying to make biweekly payroll out of thousands of FDIC-insured savings accounts, or piles of $100 bills stored in physical vaults.

The institutions which accept negative interest rates or yields have concluded, taking all of their circumstances into account, more desirable securities aren't available to them in sufficient quantity.

Yes, this does appear to be happening to a degree. One interesting aspect is that foreign investors have even been piling into U.S. municipal bonds (chart below) — even though they can't take advantage of the tax benefits and are exposing themselves to significant currency risk.

I suppose this makes sense when one can get an SEC yield of 1.3% on Vanguard's Limited-Term Tax-Exempt fund today, but only negative interest rates on your shorter-term government bonds at home.

Amazed you did not think of exchange rate risk?

The currency forward rate will wipe out the profit. All studies suggest Covered Interest Parity holds. Maybe a market maker can make money from this trade but any investor will take on currency risk.

Why can't foreign investors hedge this risk just the same as US investors do in e.g. a hedged international bond fund?

I think they can and probably do.

To see this, read what Vanguard writes about Covered Interest Parity and understand how hedged bond funds work.

Vanguard states correctly that covered interest parity ensures that there is a no-arbitrage relationship in investing in assets with similar risk profiles but denominated in different currencies.

However, understand that the hedge in bond funds is generally short - one to three months, while the holdings can be much longer. BNDI for instance has duration of over 7 years.

So ask yourself if you think a one to three month bond has the same risk profile as 3, 5, 7, 10 or 20 year ones (which would be included in most funds that have a 7+ year duration to balance off the shorter ones).

For a Swiss investor for example, the hedge yield for one month bonds would be -0.93%** (i.e. the Franc is expected to strenthen). But the seven year return difference, for example, is 1.38% higher for US bonds. So, a Swiss investor hedging a 7 year US treasury would have returns of 0.45%. Still under inflation at 0.52% (per the chart) but much better that the 7 year Franc return of -0.35%.

Of course these relationships change over time and differ by currency and yield curves.

Other than those, bond yields are set by continuous, ongoing auctions. Nobody buys a bond with a yield to maturity, YTM, lower than they will accept, even if it's negative.

Individual investors like us, including the very wealthy, have options institutions often do not. Imagine a company like Facebook trying to make biweekly payroll out of thousands of FDIC-insured savings accounts, or piles of $100 bills stored in physical vaults.

The institutions which accept negative interest rates or yields have concluded, taking all of their circumstances into account, more desirable securities aren't available to them in sufficient quantity.

PJW

Commerzbank apparently actually considered taking all its deposits out of the ECB in Frankfurt, and storing them as physical cash, Euro notes, in their vaults.

I think they were dissuaded from doing so, but it was discussed enough that it reached the financial press.

You understand, but the casual reader may not, that a nominal bond yield which is negative simply means your cash returns from the bond (coupons plus redemption) are less than the price of the bond.

However:

1. if prices are expected to fall by more than that, you can still have a positive real yield. If bond is trading at -1.0% yield, inflation expected to be 1.5% you'd still have a +0.5% real yield over the life of the bond (approximately).

2. they serve as currency plays. For example if you are bullish on the Swiss franc, holding a 10 year CHF bond is a good way to play it

3. your point i.e. If you are a Swiss pension fund or insurance company with CHF liabilities to policyholders, then holding a bond which pays out in CHF is the best hedge

I'm curious if retail clients and the average person on the street ever saw negative interest rates on their deposits? Or is this the negative rate primarily between the central bank and other lending institutions?

Not the average person but my bank in Switzerland has a negative interest rate on accounts with cash balances larger then 1 Million. Not that mit matter for me

I'm curious if retail clients and the average person on the street ever saw negative interest rates on their deposits? Or is this the negative rate primarily between the central bank and other lending institutions?

Not the average person but my bank in Switzerland has a negative interest rate on accounts with cash balances larger then 1 Million. Not that mit matter for me